From the November 2010 issue of Treasury & Risk magazine

Spotlight on Executive Pay

The clock is ticking for companies to comply with the first Dodd-Frank requirement concerning executive compensation. When they start sending out their 2011 proxies this spring, companies must include an explanation of how top executive officers' pay tracks with the company's performance. Companies are free to use whatever calculations and formulas they want, since the Securities and Exchange Commission will not publish a rule setting out metrics for this disclosure until after 2011 proxies are mailed. But the choice is fraught with risks because Dodd-Frank also mandates that companies give shareholders a nonbinding "say on pay" resolution in 2011.

"From our perspective, each company will need to do some analysis on their own, and they need to start doing that now, because different methodologies lead to different results," says Steve Seelig, executive compensation counsel at Towers Watson Research Center.

On the pay side, companies might use the figure in the summary compensation table of the proxy, although Seelig does not think this is what Congress was after. Using the compensation listed on executives' W-2 forms is a better option, Seelig says, but he favors using "pay realizable," which is the value of all compensation, including increases or decreases in equity value, plus income from cashing in options.

The performance measure could be based on total shareholder return, earnings per share, or a blend of the two.

Dodd-Frank also mandates a second, more controversial "pay equity" disclosure. Issuers will have to disclose the median total annual compensation of all employees excluding the CEO, the total annual compensation of the CEO, and the ratio of the two figures. The SEC has yet to set an implementation date, but companies expect that to kick in for the 2012 proxy season.

Dan Pedrotty, the AFL-CIO's director of investment, says pay equity will become the more important of the two metrics when shareholders have their say on pay. But Steve Bartlett, chairman of the Financial Services Roundtable, calls the pay equity measure "the silliest provision in Dodd-Frank's 2,300 pages."

Dodd-Frank mandates that compensation committees be independent, with the intent to make them tougher negotiators of pay packages. However, Charles Elson, a corporate governance expert at the University of Delaware, argues that the new law will create problems by insuring committees are more concerned with process--e.g., meeting SEC rules on committee and consultant independence--than with the substance of getting the best pay package.

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